(Article from Securities Law Alert, April 2018)
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On March 30, 2018, the Southern District of New York dismissed with prejudice a securities fraud action brought against an aerospace conglomerate following disclosures of SEC and DOJ investigations into potential Foreign Corrupt Practices Act (“FCPA”) violations that predated the class period. Emps. Ret. Sys. of the City of Providence v. Embraer S.A., 2018 WL 1725574 (S.D.N.Y. 2018) (Berman, J.). The court held defendants were under no obligation to admit that the company had violated the FCPA before the company had been charged and while the investigations were ongoing. The court emphasized that “companies do not have a duty to disclose uncharged, unadjudicated wrongdoing.”
Disclosure of Pending Investigations and Their Potential Adverse Consequences Is Sufficient to Satisfy the Securities Laws
The Embraer court held the company had “complied with its disclosure obligations” by informing investors of pending SEC and DOJ investigations, as well as the possible penalties and fines that could result. The court rejected plaintiffs’ contention that the company was “duty bound to alert investors to the certainty of the fraud” itself. The Embraer court underscored that “disclosure is not a rite of confession.”
The court explained that in City of Pontiac Policemen’s and Firemen’s Retirement System. v. UBS AG, 752 F.3d 173 (2d Cir. 2014), the Second Circuit found that an investment bank had satisfied its disclosure requirements under the securities laws by revealing that the bank was under investigation and could face significant adverse consequences. The Second Circuit rejected plaintiffs’ contention that “defendants were required to disclose that [the bank] was, in fact, [allegedly] engaged in an ongoing … scheme.” City of Pontiac, 752 F.3d 173.
The Embraer court also found persuasive the court’s recent decision in In re Banco Bradesco S.A. Securities Litigation, 277 F. Supp. 3d 600 (S.D.N.Y. 2017). There, the court held that a company had no obligation to inform investors that it was allegedly “engaged in an unlawful bribery scheme” where it had disclosed both the existence of legal and administrative proceedings concerning that alleged scheme, as well as the potential impact of those proceedings on the company’s finances and reputation.
Plaintiffs Cannot State a Securities Fraud Claim Based on the Disclosure of Accurate Financial Data
The Embraer court found meritless plaintiffs’ contention that the company was “obligated to disclose that some unstated portion of its sales or income was derived from contracts related to the FCPA violations.” The court explained that “the allegation that a corporation properly reported income that is alleged to have been, in part, improperly obtained is insufficient to impose Section 10(b) liability.” 2018 WL 1725574 (quoting In re Sanofi Sec. Litig., 155 F. Supp. 3d 386 (S.D.N.Y. 2016)).
Because plaintiffs did “not dispute that [the company’s] financial statements were (literally) accurate,” the court held that the “the statements or omissions concerning [the company’s] financial statements are not actionable.” The court stated that “a violation of federal securities laws cannot be premised upon a company’s disclosure of accurate historical data.” Id. (quoting Sanofi, 155 F. Supp. 3d 386).
A Code of Ethics Cannot Give Rise to a Securities Fraud Claim
The court further held that plaintiffs could not state a claim based on the company’s alleged failure to comply with its code of ethics, which the court found “inherently aspirational.” The court noted that “it cannot be that every time a violation of that code occurs, [the company] will be liable under federal [securities] laws.”
Plaintiffs Failed to Allege the Company’s Opinion Concerning Reserves Was Not Sincerely Held
Plaintiffs also challenged the company’s opinion, based on advice of counsel, that there was “no basis for estimating reserves or quantifying any possible contingency” in connection with the DOJ and SEC investigations of the alleged FCPA violations. In plaintiffs’ view, the company could have quantified reserves by reference to the scope of the alleged bribery scheme.
The Embraer court held that plaintiffs could not state a claim merely by alleging that the company’s opinion was wrong. Here, plaintiffs did “not plead that this statement was (insincerely) not truthful or that management (and its outside counsel) did not believe what they were stating publicly.” Plaintiffs simply “disagree[d] with the opinion.” The court explained that “‘[t]he securities laws do not allow investors to second-guess inherently subjective and uncertain assessments.’” Id. (quoting In re Weight Watchers Int’l Sec. Litig., 2016 WL 2757760 (S.D.N.Y. May 11, 2016)).
Plaintiffs’ Internal Control Claims Were Deficient in Light of the “Temporal Disconnect” Between the Alleged FCPA Violations and the Class Period
Finally, the Embraer court found plaintiffs’ claims concerning the adequacy of the company’s internal controls insufficiently particularized to survive a motion to dismiss. The court explained that a plaintiff asserting an internal control-based securities fraud claim must “allege specific facts concerning the purportedly deficient internal controls, including how they were deficient, when and why.”
Here, the court found plaintiffs pled only generalized allegations concerning the company’s internal controls and then attempted to link those allegations to current employees’ knowledge of, or participation in, alleged FCPA violations that occurred before the commencement of the class period. The court agreed with defendants that there was a “‘temporal disconnect’ between bribery events [that] occurred well before the [c]lass period and [the] alleged faulty internal controls.”
The Embraer court distinguished In re Petrobras Sec. Litig., 116 F. Supp. 3d 368 (S.D.N.Y. 2015), in which the court “apparently did not require the plaintiffs to present more detailed information about the defendant’s internal controls.” Id. The Embraer court explained that in Petrobras, “both the statements and the alleged corruption occurred during the class period.” Here, however, the alleged bribery scheme “occurred five years prior to the [c]lass [p]eriod.” The Embraer court found plaintiffs’ allegations “temporally and logically insufficient” to give rise to an internal controls-based claim.